Defense stocks stage rally as Trump discusses defense spending jump

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The White House wants $54 billion more in defense spending for fiscal 2018 — news that is being well received Monday for investors in major defense stocks.

Lockheed Martin is up about 2 percent, Raytheon ahead 1.3 percent and Northrop Grumman advanced 1.7 percent. Boeing gained about 1 percent while General Dynamics was up just fractionally.

"With the exception of General Dynamics today, everybody is up between 1 and 2 percent," said Richard Safran, a defense stock analyst at Buckingham Research in New York. "In general, defense stocks move in a herd."

Lockheed has been "a little out of favor" until recently, Safran said, so given it's been an underperformer year-to-date that may help explain why it's slightly higher than many of its peers Monday.

Even before Monday, many of the large defense stocks were already up by double-digit percentages based on expectations for an improved outlook for U.S. defense spending in the administration of President Donald Trump.

"This budget will be a public safety and national security budget," Trump said in remarks Monday at the White House. Trump called it a "historic increase in defense spending to rebuild the depleted military of the United States of America at a time we most need it."

The fiscal 2018 budget would be for the government's next fiscal year starting Oct. 1, 2017. With the additional $54 billion in defense spending, it would represent a nearly 10 percent increase overall for defense to $603 billion.

"It is a good down payment and a very positive signal that will have a very beneficial effect," said Thomas Spoehr, director of the Center for National Defense at the Heritage Foundation in Washington, D.C.

However, some influential lawmakers were quick to criticize the defense spending jump as too little.

"Over the course of the Obama Administration, our military funding was cut 20 percent while the world grew more dangerous," said Rep. Mac Thornberry (R-Texas), chairman of the House Armed Services Committee, in a statement Monday. "While we cannot repair all of the damage done by those cuts in a single year, we can and should do more than this level of funding will allow."

Added Thornberry, "The administration will have to make clear which problems facing our military they are choosing not to fix."

In January, Senate Armed Services Chairman John McCain (R-Ariz.) proposed a $640 billion base defense budget for fiscal 2018. CNBC reached out to McCain for comment.

Trump said the jump in defense spending will be offset by "finding greater savings and efficiencies across the federal government. We're going to do more with less and make the government lean and accountable to the people."

There will be a "large reduction in foreign aid" as well as cuts to "lower priority programs," an official from the Office of Management and Budget was quoted as telling reporters, according to NBC News.

"Just recommending the budget is one thing; Congress still has to figure out how to pay for it with no deal yet agreed to on spending cap relief from the Budget Control Act of 2011," Deutsche Bank analyst Myles Walton said in a research note Monday.

According to Walton, without a change to the BCA caps, U.S. defense spending in fiscal 2018 would be basically flat on a year-over-year basis.

Analysts say the Trump administration also could utilize the so-called Overseas Contingency Operations, or OCO account, to produce increased defense spending. That said, the new OMB Director Mick Mulvaney is known to be a critic of using the OCO account to get around the BCA caps.

"Mulvaney has not been a fan of OCO — the war funding," said Mark Cancian, a senior adviser with the Center for Strategic and International Studies' International Security Program in Washington, D.C. "He has said he wants to offset any defense increases with domestic cuts. But the Democrats have refused to do that."

Even so, putting money in the OCO account was a way the Obama administration got around some of the BCA caps and got Congress to go along with it.

It's unclear at this time if the Trump administration is proposing more money in the OCO account. Yet the increased efforts to defeat ISIS are likely to result in the war funding account going up.

Katherine Blakeley, a research fellow at the nonpartisan Center for Strategic and Budgetary Assessments, said there's "a broad consensus in Congress that the Budget Control Act should be repealed and that the legislature and the executive should be able to think about the needs of our domestic priorities, think about the needs of our defense priorities and square those. So far they've failed to do that."

By Jeff Daniels

Source: http://www.cnbc.com/2017/02/27/defense-stocks-stage-rally-as-trump-discusses-defense-spending-jump.html

Defense Contractor Stocks in a Trump Administration

© (LM Otero/AP Photo) FILE - In this July 7, 2006, file photo, the Lockheed Martin F-35 Joint Strike Fighter is shown after it was unveiled in a ceremony in Fort Worth, Texas. Shares of Lockheed Martin fell Monday, Dec. 12, 2016, as President-elect…

President Donald Trump's push for more military spending bodes well for defense contractors, but it's unknown which names in the space are most likely to benefit.

The bullish point of view is that Trump's call for more troops, new ships and new planes will increase defense spending. "President Trump will end the defense sequester and submit a new budget to Congress outlining a plan to rebuild our military," the White House website says.

At the same time, Trump has used Twitter to criticize the costs of Lockheed Martin Corp.'s (ticker: LMT) F-35 fighter jet and Boeing Co.'s (BA) next generation Air Force One, prompting some concern about defense company margins.

While the market is correct to believe defense spending is headed higher, some stocks will benefit more than others, and not all the spending will flow to contractors, says Morningstar analyst Chris Higgins.

However, with 2017 spending not finalized and the 2018 budget request not yet made public, "everyone's still reading the tea leaves," Higgins says.

The military budget includes personnel costs such as salary and benefits, operations and maintenance of facilities around the world and the development and buying of weapons. It's this latter part that investors should pay particular attention to, as much of the research and development and procurement money flows to contractors, says Credit Suisse analyst Robert Spingarn.

Former President Barack Obama's fiscal year 2017 budget request for the Department of Defense was about $580 billion, but Credit Suisse expects Trump to add $26 billion to $30 billion to the finalized 2017 budget.

Defense stocks have also been rallying in hopes of boosted spending in the fiscal year 2018 budget request, as well as the general pro-national security tone of Trump's campaign and administration, Spingarn says.

Even though the market has priced in quite a bit already, there could still be some buying opportunities, Higgins says.

If there is disappointment in the finalized 2017 budget and the release of the 2018 budget request, some of the stocks could pull back, he says.

But even if the budgets come in lower than expected, there could still be growth, he says. And for those willing to research and who know the defense industry, there could be pockets for longer-term investors that not everyone in the market is paying attention to. "These budgets are not exactly easy reading," Higgins says.

However, another side to the Trump administration is that he may push the contractors for lower prices on certain products, Spingarn says, noting Trump's tweets about the price of the F-35 and Air Force One.

When prices come down, particularly on products where volume is important, companies could see lower margins, Spingarn says. "We call Trump a potential double-edged sword," he says. "While he's busy spending more money he's also asking for lower prices."

Buckingham Research Group analyst Richard Safran, however, doesn't think Trump's policies will pressure margins, noting price reductions were already planned for the F-35 even before his tweet. "I don't think he is going to attack margins," he says.

While there is potential for slightly greater pricing pressure on future contracts, the large prime contractors are shielded to a certain extent from attempts to cut into their margins because there are few companies able to compete for the unique products they can provide, Goldman Sachs analysts say in a January note.

Additionally, the sector on average is still attractive even with lower margins, the analysts say. But if margins do come under pressure, companies with less prime contracting work such as L3 Technologies (LLL), Harris Corp. (HRS) and FLIR Systems (FLIR) "could be more attractive to the investor concerned with headline risk."

The Defense Department's priorities will benefit contractors with more exposure to land forces of the Army and Marine Corps., particularly General Dynamics Corp. (GD).

Trump's push for ship building also bodes well for General Dynamics, as well as pure-play ship builder Huntington Ingalls Industries (HII). "Navy's going to be a big theme for defense spending under this president," Spingarn says.

He expects supplemental military spending will include ship depot maintenance and precision-guided munitions, which favors Raytheon (RTN) and Lockheed Martin in addition to General Dynamics. 

Potentially more F/A-18 Super Hornets for the Navy would benefit Boeing – that Trump tweet about the F-35 said he had asked Boeing to "price out a comparable F-18 Super Hornet" – and more F-35s for the Marines would benefit Lockheed Martin, according to Spingarn. Orders for both would be a boon for Northrop Grumman Corp. (NOC), which works on both programs, he says.

By Matt Whittaker

Source: http://www.msn.com/en-us/money/topstocks/defense-contractor-stocks-in-a-trump-administration/ar-AAn3Dy4